Public Economics:Theory and Policy, Essays in Honor of Amaresh Bagchi
Edited by M. Govinda Rao and Mihir Rakshit
This one-stop book on public economics is a tribute to economist Amaresh Bagchi. Edited by M. Govinda Rao and Mihir Rakshit, Public Economics is a compilation of 10 eclectic articles covering the entire gamut of relevant and important issues. Expectedly, there is a chapter on Bagchi and his contribution to India’s fiscal policy. The article evaluates the extent to which fiscal deficit targets make sense in our economy, considering our socio-economic goals, which make static targets quite irrelevant. Complimenting this view is an article on how we should be broad basing our tax system and lowering rates.
The book presents Bagchi’s pioneering work on consumption tax and highlights issues in bringing about harmonisation in our federal set-up. This is followed by Rao’s own take on federalism. An interesting survey that says gains of peace, trade and environment have led to interest in these global public goods. Curiously, it says that the WTO and the UN Framework Convention on Climate Change do not quite focus on developmental concerns. An article on environment taxes highlights how industries can cope with this through a ‘cap and trade’ scheme.
The last few articles are more conceptual. The final piece comprising budgetary principles, non-tax revenues and global fiscal concerns, belongs more in a class room and can put off the reader. On the whole, the book is a commendable compilation that will appeal to students and probably, bureaucrats and is worth reading.
(This story was published in Businessworld Issue Dated 02-01-2012)
Monday, January 9, 2012
An uncertain banking scenario: Financial Express: 30th December 2011
The current year has been quite a disappointment for the banking sector. This is not unusual as the fortunes of this sector are inexorably linked with that of the real sector. With industry down, GDP growth slowing down, interest rates rising and inflation peaking, banking performance has been affected in terms of net interest income and profits. The darker icing is the prospect of increasing NPAs on account of the downturn, which has also been highlighted by the RBI’s FSR. How would things look like in 2012?
The edifice for the banking sector in 2012 will be built by the state of the economy or rather the pace of recovery. Here there are varying views. There is a section that believes that the slowdown of FY12 will be exacerbated in FY13, but that may be overstating the impact. It may be assumed that there will be a recovery, albeit a gentle one, given that a lot has to happen to accelerate the process, which depends on the monetary stance of RBI. Today, investment is down as is leveraged-based consumption, which has to reverse soon. Investment takes time to take off because even if rates move down, expectations of the same will drive the pace of investment. If industry believes that a rate reversal has set in, then they would enter based on future expectations, which, in turn, will lead to lags in actual investment. This means that, to begin with, a cautious approach would be taken. The starting point hence will be RBI.
RBI will be the fulcrum for bank performance as its stance on interest rates will drive consumption and investment. Monetary policy is likely to hold the key to progress since the government, on its part, will tend to be more conservative with its budgetary policy. More likely, it will tread cautiously here and ensure that inflation is reined in before really releasing the pedal. This can happen earliest in the first quarter of FY13, and anything earlier will be a bonus.
The challenge for banks henceforth will be five-fold. First, they will have to endeavour to recreate their asset portfolios. Today, both the corporate and retail loan books have been afflicted by the economic environment and hence stepping up credit, especially on investment and retail loans, will be challenging as borrowers will wait for rates to come down further to seize the opportunity. And borrowers will be waiting for rates to decline further so as not to be caught in an interest trap. There will have to be some kind of a joint effort on the part of the auto and housing sectors to enthuse customers, while capital investment would tend to be cautious to begin with.
Second, banks have to work hard at raising capital to ensure that they have adequate capital to support the growth in their loan books. While banks are well capitalised at present (though the ratio has been falling in FY12), with growth in credit expected to be in the region of 20% per annum, the annual incremental capital requirement would be starting from R80,000 crore and move up to R100,000 crore in the next 5 years. Work evidently has to start from this year itself. Capital buffers are an extremely important component of the new macro-prudential regulatory framework that aims at improving both quality and quantity of capital. Now, capital is a competitive charge on the resources available for lending with a bank and hence stepping up counter-cyclical capital requirements and providing capital buffers will be a cost for the banking system. Capital enhancement is an inevitable prudential requirement and
prudent risk management has assumed considerable importance against the backdrop of the financial crisis.
Third, as liquidity is an issue under Basel 3, banks will have to necessarily look closely at building up systems to meet these norms going ahead. Fourth, risk management becomes important in the light of experiences of the financial crisis. Market risk has become more volatile both on interest rate and forex exposures while that on derivatives and other off-balance sheet items would require closer scrutiny. One cannot really be sure about the exchange rate as the euro crisis lingers. Interest rates, too, would be idiosyncratic depending on government borrowing, a pick up in the economy, bank credit and the RBI stance on the same.
Lastly, they would have to start looking closely at the quality of their assets in the light of the developments in the current year. The first two quarters of FY12 indicate an increase in the NPAs of the banking sector, which could probably be under pressure going ahead. Therefore, the task of banks is to make adequate provisioning and cover which will have a bearing on the profit levels. A rainbow in this scenario would be the treasury income as declining interest rates would mean gains for banks in the G-Sec market.
At the policy level, there are some changes that may be expected for the banks. Assuming that the governance issues are addressed and more time is spent on discussing reforms, these are exciting times for this sector. First, the issue of new banks will be addressed with permission being given to more banks to open shop. There have been constructive debates so far, and it may be expected that we can see this policy being implemented.
Second, the impasse on foreign banks and their route to operations through subsidiaries or branches should also be resolved this year. The resolution of these issues will provide a competitive thrust to the industry which will, in turn, make banks rework their business models. It must be remembered that the new bank concept will have a tilt towards inclusion, which will be major consideration for the others too.
A sub-sector that will become more important with reforms coming in would be MFIs. There is restructuring going on in some of the major MFIs that will help to channel funds in this direction. Given the political expediency for 2013, the government will be pushing hard at expanding inclusive lending, which will provide an impetus to this sector.
So, how would the soothsayer describe the prospects? It will be mildly positive but bordering more on caution as systems will be put in order as banks work
on reconstructing their business models under the umbrella of some interesting reforms. The liabilities side should be normal while asset creation takes the backseat, and the treasury vaults keep jingling all the way with volatility guiding these prospects.
The edifice for the banking sector in 2012 will be built by the state of the economy or rather the pace of recovery. Here there are varying views. There is a section that believes that the slowdown of FY12 will be exacerbated in FY13, but that may be overstating the impact. It may be assumed that there will be a recovery, albeit a gentle one, given that a lot has to happen to accelerate the process, which depends on the monetary stance of RBI. Today, investment is down as is leveraged-based consumption, which has to reverse soon. Investment takes time to take off because even if rates move down, expectations of the same will drive the pace of investment. If industry believes that a rate reversal has set in, then they would enter based on future expectations, which, in turn, will lead to lags in actual investment. This means that, to begin with, a cautious approach would be taken. The starting point hence will be RBI.
RBI will be the fulcrum for bank performance as its stance on interest rates will drive consumption and investment. Monetary policy is likely to hold the key to progress since the government, on its part, will tend to be more conservative with its budgetary policy. More likely, it will tread cautiously here and ensure that inflation is reined in before really releasing the pedal. This can happen earliest in the first quarter of FY13, and anything earlier will be a bonus.
The challenge for banks henceforth will be five-fold. First, they will have to endeavour to recreate their asset portfolios. Today, both the corporate and retail loan books have been afflicted by the economic environment and hence stepping up credit, especially on investment and retail loans, will be challenging as borrowers will wait for rates to come down further to seize the opportunity. And borrowers will be waiting for rates to decline further so as not to be caught in an interest trap. There will have to be some kind of a joint effort on the part of the auto and housing sectors to enthuse customers, while capital investment would tend to be cautious to begin with.
Second, banks have to work hard at raising capital to ensure that they have adequate capital to support the growth in their loan books. While banks are well capitalised at present (though the ratio has been falling in FY12), with growth in credit expected to be in the region of 20% per annum, the annual incremental capital requirement would be starting from R80,000 crore and move up to R100,000 crore in the next 5 years. Work evidently has to start from this year itself. Capital buffers are an extremely important component of the new macro-prudential regulatory framework that aims at improving both quality and quantity of capital. Now, capital is a competitive charge on the resources available for lending with a bank and hence stepping up counter-cyclical capital requirements and providing capital buffers will be a cost for the banking system. Capital enhancement is an inevitable prudential requirement and
prudent risk management has assumed considerable importance against the backdrop of the financial crisis.
Third, as liquidity is an issue under Basel 3, banks will have to necessarily look closely at building up systems to meet these norms going ahead. Fourth, risk management becomes important in the light of experiences of the financial crisis. Market risk has become more volatile both on interest rate and forex exposures while that on derivatives and other off-balance sheet items would require closer scrutiny. One cannot really be sure about the exchange rate as the euro crisis lingers. Interest rates, too, would be idiosyncratic depending on government borrowing, a pick up in the economy, bank credit and the RBI stance on the same.
Lastly, they would have to start looking closely at the quality of their assets in the light of the developments in the current year. The first two quarters of FY12 indicate an increase in the NPAs of the banking sector, which could probably be under pressure going ahead. Therefore, the task of banks is to make adequate provisioning and cover which will have a bearing on the profit levels. A rainbow in this scenario would be the treasury income as declining interest rates would mean gains for banks in the G-Sec market.
At the policy level, there are some changes that may be expected for the banks. Assuming that the governance issues are addressed and more time is spent on discussing reforms, these are exciting times for this sector. First, the issue of new banks will be addressed with permission being given to more banks to open shop. There have been constructive debates so far, and it may be expected that we can see this policy being implemented.
Second, the impasse on foreign banks and their route to operations through subsidiaries or branches should also be resolved this year. The resolution of these issues will provide a competitive thrust to the industry which will, in turn, make banks rework their business models. It must be remembered that the new bank concept will have a tilt towards inclusion, which will be major consideration for the others too.
A sub-sector that will become more important with reforms coming in would be MFIs. There is restructuring going on in some of the major MFIs that will help to channel funds in this direction. Given the political expediency for 2013, the government will be pushing hard at expanding inclusive lending, which will provide an impetus to this sector.
So, how would the soothsayer describe the prospects? It will be mildly positive but bordering more on caution as systems will be put in order as banks work
on reconstructing their business models under the umbrella of some interesting reforms. The liabilities side should be normal while asset creation takes the backseat, and the treasury vaults keep jingling all the way with volatility guiding these prospects.
A look back at 2011: Financial Express: 27th December 2011
The Billboard for the year will have no surprises with Adele, Bruno Mars, Eminem, Rihana, Beyonce, Coldplay and company taking the honours. The world of economics and finance, too, has its top-10 that are laced with irony given their importance and our helplessness at finding a solution.
At number 10 is the euro crisis, which is a cerebral challenge to globalisation with the threat of economic contagion looming. The house of cards kept crumbling and despite all the funds coming from the ECB, ESFC, IMF and the rest, it was still a game of nine pins. Greece was peripheral, but given that the contagion has reached Italy, there is some trepidation that France too may be on the road to hell.
At 9, is the IMF for different reasons. Dominique Strauss-Kahn made all the wrong moves and they were beyond sleaze and Hollywood. Who can now say that the IMF is irrelevant, as even India hoped to have its own person at the helm? However, the glass ceiling does still exist for developing countries—Raghuram Rajan notwithstanding.
The 8th spot is occupied by Obama and the US. Never in contemporary economic history could anyone have ever thought that the US would default. But the Senate held the purse strings and the world hiccuped at this prospect. It gave the media, critics and economists room to debate what would happen as D-day drew nearer. But the debt limit was approved and the dollar rebounded with a vengeance to give all currencies a run.
At 7, back home it was the year of denial. We were sure of growth this year and the constant media glare had different personalities of the government spewing optimism, more than that for Sachin’s 100th 100. The gallop off 9% has slowed to a trot of 7%. Investment banks, which are known for always downplaying the India story when the chips are down, are sporting the ‘I told you so’ smirk.
Inflation is at the 6th position. It was so reassuring to have various experts tell us that inflation will come down, though one never knew the basis of these guesses. They appeared to be drawn more on the basis of hope and buying time, as time—which the bard on Stratford on Avon had called the great healer—would take care of the same. More importantly, everybody was pulling in a different direction. The agriculture ministry wanted more prices for farmers, the petroleum ministry wanted market driven petro-product prices and the finance ministry, a lower deficit. But, everyone looked at Mint Street to keep pulling the trigger, which at times seemed as if it was firing into space.
The halfway mark is in the area of interest rates. RBI kept raising rates and everyone squealed. India Inc cried that higher rates would squeeze investment. But then was that not the purpose of increasing rates? After all, if higher rates did not deter borrowing, then monetary policy would have been impotent! How else did these chieftains expect rate cuts to work?
At the 4th spot is the infamous FDI in retail. This was the big bang theory that would work. Walmart would come and create cold chains from the Indus to the Cauvery, and buy good quality stuff from farmers and pay them higher prices so that our farm output increases. This big apple vision went the way of all dreams that are based on building castles in the air. The noise in Parliament was louder than its justification.
At the third spot, the exchange rate turned out to be the joker in the pack. A year ago, we were hassled when dollars came in and the rupee became stronger. We wanted RBI to intervene, and MSS bonds were spoken of. But now, with the rupee taking a beating, one is again not sure of what we should do. Should we use our reserves to fight the depreciation? What are they meant for anyway? We are still thinking.
The second spot is the Food Security Bill. We are against poverty, but we do not want to spend on the poor. The deficit will increase and the economy will be affected, you see. This is middle class morality, with hopes of jugaad. Remember how the MFIs have been stifled. This is Indian capitalism in technicolour.
The top spot goes to the concept of paralysis of policy. This is not cerebral palsy but more like Parkinson’s disease, where the limbs stop moving. The Anna twist has made Parliament an open court to discuss corruption, which has kept any movement on reforms in abeyance. The one which got to the table for discussion—FDI in retail—is now closer to the bin. Critics now say that this has kept growth down. But then we have had
9% growth all these years without these reforms in place. Do they really matter or do they just make the economy look sexier for multilateral agencies?
The year 2011 was challenging, interesting and amusing. Will this be repeated in 2012?
At number 10 is the euro crisis, which is a cerebral challenge to globalisation with the threat of economic contagion looming. The house of cards kept crumbling and despite all the funds coming from the ECB, ESFC, IMF and the rest, it was still a game of nine pins. Greece was peripheral, but given that the contagion has reached Italy, there is some trepidation that France too may be on the road to hell.
At 9, is the IMF for different reasons. Dominique Strauss-Kahn made all the wrong moves and they were beyond sleaze and Hollywood. Who can now say that the IMF is irrelevant, as even India hoped to have its own person at the helm? However, the glass ceiling does still exist for developing countries—Raghuram Rajan notwithstanding.
The 8th spot is occupied by Obama and the US. Never in contemporary economic history could anyone have ever thought that the US would default. But the Senate held the purse strings and the world hiccuped at this prospect. It gave the media, critics and economists room to debate what would happen as D-day drew nearer. But the debt limit was approved and the dollar rebounded with a vengeance to give all currencies a run.
At 7, back home it was the year of denial. We were sure of growth this year and the constant media glare had different personalities of the government spewing optimism, more than that for Sachin’s 100th 100. The gallop off 9% has slowed to a trot of 7%. Investment banks, which are known for always downplaying the India story when the chips are down, are sporting the ‘I told you so’ smirk.
Inflation is at the 6th position. It was so reassuring to have various experts tell us that inflation will come down, though one never knew the basis of these guesses. They appeared to be drawn more on the basis of hope and buying time, as time—which the bard on Stratford on Avon had called the great healer—would take care of the same. More importantly, everybody was pulling in a different direction. The agriculture ministry wanted more prices for farmers, the petroleum ministry wanted market driven petro-product prices and the finance ministry, a lower deficit. But, everyone looked at Mint Street to keep pulling the trigger, which at times seemed as if it was firing into space.
The halfway mark is in the area of interest rates. RBI kept raising rates and everyone squealed. India Inc cried that higher rates would squeeze investment. But then was that not the purpose of increasing rates? After all, if higher rates did not deter borrowing, then monetary policy would have been impotent! How else did these chieftains expect rate cuts to work?
At the 4th spot is the infamous FDI in retail. This was the big bang theory that would work. Walmart would come and create cold chains from the Indus to the Cauvery, and buy good quality stuff from farmers and pay them higher prices so that our farm output increases. This big apple vision went the way of all dreams that are based on building castles in the air. The noise in Parliament was louder than its justification.
At the third spot, the exchange rate turned out to be the joker in the pack. A year ago, we were hassled when dollars came in and the rupee became stronger. We wanted RBI to intervene, and MSS bonds were spoken of. But now, with the rupee taking a beating, one is again not sure of what we should do. Should we use our reserves to fight the depreciation? What are they meant for anyway? We are still thinking.
The second spot is the Food Security Bill. We are against poverty, but we do not want to spend on the poor. The deficit will increase and the economy will be affected, you see. This is middle class morality, with hopes of jugaad. Remember how the MFIs have been stifled. This is Indian capitalism in technicolour.
The top spot goes to the concept of paralysis of policy. This is not cerebral palsy but more like Parkinson’s disease, where the limbs stop moving. The Anna twist has made Parliament an open court to discuss corruption, which has kept any movement on reforms in abeyance. The one which got to the table for discussion—FDI in retail—is now closer to the bin. Critics now say that this has kept growth down. But then we have had
9% growth all these years without these reforms in place. Do they really matter or do they just make the economy look sexier for multilateral agencies?
The year 2011 was challenging, interesting and amusing. Will this be repeated in 2012?
Securing food security: Financial Express 22nd December 2011
In a country like India, the state of human deprivation is high. The level of poverty, depending on which side of the fence one is sitting, ranges from 25-45% based on different yardsticks used. We operate in a market system where the private sector, driven, as it were, by the profit factor, has enough room to work for self-fulfilment. The government, on the other hand, by its very nature, has to balance contradictions in society and hence has an obligation to providing the poor with a minimum sense of existence. Based on this thought, the Food Security Bill should be welcomed as it aims at providing food to the poor. The why of this cannot be questioned provided the delivery is as per the objectives laid down. What are the issues involved in the successful implementation of such a Bill?
First, the Bill looks at providing foodgrains, which include rice, wheat and coarse cereals. But this is not comprehensive as people cannot really live only on cereals without having access to other food components like, say, edible oil, fuel, etc, which are outside the purview. Therefore, some thought should have also gone into making the package self-sufficient rather than leaving it open. The poor should move beyond survival.
Second, identification of the targeted people is important. There is already some controversy regarding the people covered under MGNREGA. Will it be a case that the incorrect set of people gets targeted in this scheme? We need to have the targeted groups identified quite correctly through systems to ensure that there is no adverse selection. The UIDAI can be a solution but would take time to be put in place.
Third, we need to look at our own ability to deliver the quantity of foodgrains that we are talking of. Today, the FCI procures around 55 million tonnes of foodgrains, which will have to increase to enable the successful implementation of the programme. Currently, the procurement is restricted to specific states such as UP, Punjab, Haryana, Orissa, Bengal, Andhra Pradesh, etc. We need to have strong machinery for widening this coverage so that not only do farmers across the country benefit from procurement but also delivery becomes easier. The disconnect between procurement and PDS creates inefficiencies that need to be plugged.
Fourth, the basic productivity levels have to increase to ensure that we are able to provide these foodgrains to a growing population. As the coverage ratio is going to increase, we need to have substantial investments in farming, which has to come mainly from the government. Therefore, we need to have the right allocations in place and address issues of productivity, cropping pattern, irrigation, use of fertilisers, etc. The government’s budgetary numbers should hence be viewed beyond plain vanilla subsidy numbers as the pressure on the allocation side will increase. We must also realise that while additional procuring through increased MSPs has worked in the past, it has been at the cost of cropping patterns, with farmers moving away from pulses and oilseeds, where there is a perennial shortage.
Fifth, we need to improve our agriculture infrastructure post harvest from the farm gate to the consumer, which is constrained by limited warehousing and transport facilities. To ensure free movement, we also need to improve the sale laws involving APMCs, which means revisiting agro reforms.
Sixth, and most important, is the delivery mechanism. The government machinery is considered to be sub-optimal when it comes to delivery of PDS and various modalities have been argued. A way out is to actually privatise the distribution system to bring in efficiency, which can be achieved through selective outsourcing. This can be experimented with at the stage of procurement too in non-FCI states so that the entire system works in harmony.
Hence, it does appear that administration of food security is a challenge beyond budgetary numbers, which seems to have caught everyone’s attention. Ideally, one needs to have all the agro reforms in place before embarking on such an exercise or else the scheme will be a non-starter or a simple failure. On the positive side, this issue should inspire us to get our act together, because successful implementation of the Food Security Act would necessarily bring about far reaching changes in the way in which farming is done. The PDS system will also get reformed.
Now, practically speaking, given that we have an impasse relating to any reform in this sector, whether it is FDI or APMC laws or contract farming, it will be quite ambitious to really think that this can be done in a couple of years’ time despite the political expediency here. A more prudent approach will be to actually implement this scheme through pilot projects in specific states and communities that are really in need of such support or else we run the risk of only making allocations without creating value, which will be self-defeating.
The message clearly is that we definitely need food security and the amount involved cannot be the reason for not doing it. We should seize this opportunity and create structures that can transform the lives of the poor. MGNREGA was a good beginning, albeit without much focus, and we should ensure that this works, because it can if we want it to.
First, the Bill looks at providing foodgrains, which include rice, wheat and coarse cereals. But this is not comprehensive as people cannot really live only on cereals without having access to other food components like, say, edible oil, fuel, etc, which are outside the purview. Therefore, some thought should have also gone into making the package self-sufficient rather than leaving it open. The poor should move beyond survival.
Second, identification of the targeted people is important. There is already some controversy regarding the people covered under MGNREGA. Will it be a case that the incorrect set of people gets targeted in this scheme? We need to have the targeted groups identified quite correctly through systems to ensure that there is no adverse selection. The UIDAI can be a solution but would take time to be put in place.
Third, we need to look at our own ability to deliver the quantity of foodgrains that we are talking of. Today, the FCI procures around 55 million tonnes of foodgrains, which will have to increase to enable the successful implementation of the programme. Currently, the procurement is restricted to specific states such as UP, Punjab, Haryana, Orissa, Bengal, Andhra Pradesh, etc. We need to have strong machinery for widening this coverage so that not only do farmers across the country benefit from procurement but also delivery becomes easier. The disconnect between procurement and PDS creates inefficiencies that need to be plugged.
Fourth, the basic productivity levels have to increase to ensure that we are able to provide these foodgrains to a growing population. As the coverage ratio is going to increase, we need to have substantial investments in farming, which has to come mainly from the government. Therefore, we need to have the right allocations in place and address issues of productivity, cropping pattern, irrigation, use of fertilisers, etc. The government’s budgetary numbers should hence be viewed beyond plain vanilla subsidy numbers as the pressure on the allocation side will increase. We must also realise that while additional procuring through increased MSPs has worked in the past, it has been at the cost of cropping patterns, with farmers moving away from pulses and oilseeds, where there is a perennial shortage.
Fifth, we need to improve our agriculture infrastructure post harvest from the farm gate to the consumer, which is constrained by limited warehousing and transport facilities. To ensure free movement, we also need to improve the sale laws involving APMCs, which means revisiting agro reforms.
Sixth, and most important, is the delivery mechanism. The government machinery is considered to be sub-optimal when it comes to delivery of PDS and various modalities have been argued. A way out is to actually privatise the distribution system to bring in efficiency, which can be achieved through selective outsourcing. This can be experimented with at the stage of procurement too in non-FCI states so that the entire system works in harmony.
Hence, it does appear that administration of food security is a challenge beyond budgetary numbers, which seems to have caught everyone’s attention. Ideally, one needs to have all the agro reforms in place before embarking on such an exercise or else the scheme will be a non-starter or a simple failure. On the positive side, this issue should inspire us to get our act together, because successful implementation of the Food Security Act would necessarily bring about far reaching changes in the way in which farming is done. The PDS system will also get reformed.
Now, practically speaking, given that we have an impasse relating to any reform in this sector, whether it is FDI or APMC laws or contract farming, it will be quite ambitious to really think that this can be done in a couple of years’ time despite the political expediency here. A more prudent approach will be to actually implement this scheme through pilot projects in specific states and communities that are really in need of such support or else we run the risk of only making allocations without creating value, which will be self-defeating.
The message clearly is that we definitely need food security and the amount involved cannot be the reason for not doing it. We should seize this opportunity and create structures that can transform the lives of the poor. MGNREGA was a good beginning, albeit without much focus, and we should ensure that this works, because it can if we want it to.
Monetary policy: pause and effect: Buisness Standard 17th December 2011
The credit policy had to be drafted against the backdrop of a series of economic concerns: low growth, uncertain inflation, liquidity crunch and a volatile rupee. The Reserve Bank of India (RBI) had several options as there was a strong justification for both doing and not doing anything. With growth being down, rates could have been cut. But this was not expected; one could hope for a pause in rate hike at best. Rate hikes could be justified: inflation was high – at above nine per cent – with core inflation still in the danger range. But, given that it was caused by cost factors such as rupee depreciation, there was a case for leaving rates alone.
Liquidity has been an issue, with average daily borrowings of over Rs 1 lakh crore from the RBI through the repo auctions, which is above the RBI’s comfort level of Rs 60,000 (one per cent of NDTL). To induce liquidity, a cut in the cash reserve ratio (CRR) would have helped. But the RBI has stated all along that this would provide a contrary signal and hence there was reason not to touch it. Finally, given forex volatility, one could have expected the RBI to act in terms of either direct intervention or strong statements. However, the RBI has been reiterating that it does not want to do either – since the rupee is being driven by extraneous forces including fundamentals – and that it does not have the wherewithal to support the same.
Given these multiple options, the RBI has actually chosen not to do anything, hence all rates have been left unchanged. The statement has been clothed with guarded words, which talk of pressures on growth and inflation looking more manageable, albeit with the prefix of caution. By restating the inflation target of seven per cent by March, one can conjecture that the RBI will be looking closely at this progress before it considers lowering rates. This in a way is pragmatic since it eschews guesswork for the market.
The policy could, however, have done something about liquidity and currency. Liquidity is an issue because banks will require these funds to subscribe to government paper, which will be increasing in the market depending on the fiscal deficit. An additional Rs 53,000 crore of borrowing has already been announced and, ceteris paribus, any slippage in the disinvestment programme (which has now been accepted) will increase this number. Therefore, a CRR reduction would have been effective in this respect without really contravening the monetary stance of the RBI.
The issue on currency is more serious. The RBI is in charge of both forex reserves and the movement of the rupee. In the past, it has intervened in the market by supplying dollars to prop up the rupee, or bought up dollars to prevent sharp appreciation. It is one of the functions of a central bank everywhere in the world. At present, in a pre-policy measure, it has disciplined sentiment by putting curbs on rebooking cancelled forward contracts. Though the argument of not having enough reserves to fight currency depreciation is pertinent, it is important to realise that an unchecked currency will impinge on the other economic indicators, such as core inflation which ultimately becomes a consideration for rate hikes. The two are not independent.
Core inflation today is high on account of a depreciating currency, which has negated the impact of declining global commodity prices and led to an increase in the same. This is so because India is a price taker for most globally traded commodities in the metals segment as well as crude oil and oil-based products. Therefore, clearly, one guiding factor of inflation is something that needs to be controlled. It can be construed that the RBI would probably take action in course of time once it is uncomfortable with the level of exchange rate.
The RBI has shied away from providing growth forecasts — this is, again, quite understandable given that the finance ministry has already indicated 7.25-7.5 per cent. Given the inflation situation, it does appear that monetary policy can do little to stimulate growth, which means that the conundrum gets complicated. The private sector is not in a situation to invest since rates are high and there are demand issues, given that consumption is based on leverage, and investment is low. The government is the only entity that can spend, but it cannot do so given the knots it is in. Revenues are declining owing to low growth, while non-plan expenditure is non-negotiable. It cannot persevere with project expenditure, or it may have to compromise on the same to maintain the fiscal deficit.
The RBI appears to have undertaken a stocktaking exercise this time by not invoking any action ostensibly, to closely monitor developments before taking any measures on the monetary and forex front. One can surmise that its view could change in January if it is convinced that liquidity and exchange problems are more permanent. Also, the growth-and-inflation trade-off will be tested in terms of the “good harvest argument” impacting consumer spending, and hence index of industrial production, or IIP, growth and food inflation.
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Liquidity has been an issue, with average daily borrowings of over Rs 1 lakh crore from the RBI through the repo auctions, which is above the RBI’s comfort level of Rs 60,000 (one per cent of NDTL). To induce liquidity, a cut in the cash reserve ratio (CRR) would have helped. But the RBI has stated all along that this would provide a contrary signal and hence there was reason not to touch it. Finally, given forex volatility, one could have expected the RBI to act in terms of either direct intervention or strong statements. However, the RBI has been reiterating that it does not want to do either – since the rupee is being driven by extraneous forces including fundamentals – and that it does not have the wherewithal to support the same.
Given these multiple options, the RBI has actually chosen not to do anything, hence all rates have been left unchanged. The statement has been clothed with guarded words, which talk of pressures on growth and inflation looking more manageable, albeit with the prefix of caution. By restating the inflation target of seven per cent by March, one can conjecture that the RBI will be looking closely at this progress before it considers lowering rates. This in a way is pragmatic since it eschews guesswork for the market.
The policy could, however, have done something about liquidity and currency. Liquidity is an issue because banks will require these funds to subscribe to government paper, which will be increasing in the market depending on the fiscal deficit. An additional Rs 53,000 crore of borrowing has already been announced and, ceteris paribus, any slippage in the disinvestment programme (which has now been accepted) will increase this number. Therefore, a CRR reduction would have been effective in this respect without really contravening the monetary stance of the RBI.
The issue on currency is more serious. The RBI is in charge of both forex reserves and the movement of the rupee. In the past, it has intervened in the market by supplying dollars to prop up the rupee, or bought up dollars to prevent sharp appreciation. It is one of the functions of a central bank everywhere in the world. At present, in a pre-policy measure, it has disciplined sentiment by putting curbs on rebooking cancelled forward contracts. Though the argument of not having enough reserves to fight currency depreciation is pertinent, it is important to realise that an unchecked currency will impinge on the other economic indicators, such as core inflation which ultimately becomes a consideration for rate hikes. The two are not independent.
Core inflation today is high on account of a depreciating currency, which has negated the impact of declining global commodity prices and led to an increase in the same. This is so because India is a price taker for most globally traded commodities in the metals segment as well as crude oil and oil-based products. Therefore, clearly, one guiding factor of inflation is something that needs to be controlled. It can be construed that the RBI would probably take action in course of time once it is uncomfortable with the level of exchange rate.
The RBI has shied away from providing growth forecasts — this is, again, quite understandable given that the finance ministry has already indicated 7.25-7.5 per cent. Given the inflation situation, it does appear that monetary policy can do little to stimulate growth, which means that the conundrum gets complicated. The private sector is not in a situation to invest since rates are high and there are demand issues, given that consumption is based on leverage, and investment is low. The government is the only entity that can spend, but it cannot do so given the knots it is in. Revenues are declining owing to low growth, while non-plan expenditure is non-negotiable. It cannot persevere with project expenditure, or it may have to compromise on the same to maintain the fiscal deficit.
The RBI appears to have undertaken a stocktaking exercise this time by not invoking any action ostensibly, to closely monitor developments before taking any measures on the monetary and forex front. One can surmise that its view could change in January if it is convinced that liquidity and exchange problems are more permanent. Also, the growth-and-inflation trade-off will be tested in terms of the “good harvest argument” impacting consumer spending, and hence index of industrial production, or IIP, growth and food inflation.
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A bit of hope, a bit of despair Financial Express: 10th December 2011
The Indian economy presents a collage of contradictions. At the forefront is dissatisfaction at the status quo in reforms notwithstanding the government’s attempts to make things move. GST, DTC, FDI, PFRDA, land reforms, new banks, etc, are all strong statements of intent that have not quite taken off and only consumed Parliament time.
Growth prospects appear to have descended the stairs and the initial enthusiasm on the decoupling theory with the euro crisis has now given rise to second thoughts and apprehension. Inflation is a worry, not so much because it is high but because we have not really cracked a way out. Now the fiscal deficit and weak rupee have generated a fresh set of challenges for RBI and the tension is palpable. But somewhere within the periphery we have seen higher foreign direct investment and larger recourse to external commercial borrowings (ECBs) provide colour to the portrait. How then does the growth story really add up?
Our own growth expectations have scaled down considerably from the 9% assumed in the Budget to something around 7-7.5%, going by the latest
remarks by the finance ministry (Graph 1). Given that RBI has kept increasing interest rates in a bid to curb demand, this lower growth is a vindication of monetary policy as investment, leverage-based consumption and overall growth has slowed down.
Industrial growth has been declining in the last few months (Graph 2) and while there is still reason to remain sanguine, considering that this has been the slack season where there is relatively less spending, we may still not really expect a major jump in the subsequent months even with higher consumption spending. The major disappointment has been the mining sector that has gone into the negative zone, but electricity production has been robust, thus sending contrary signals.
Further, bank credit growth has slowed down, indicating that there is definitely less borrowing for production and investment. However, at the same time, there has been a steady increase in both exports and non-oil imports (Graph 3), though, admittedly, there is a declining trend. Imports go either as direct consumption or inputs for production; either which way it should get reflected in overall growth. The same holds for exports, which have been buoyant on a cumulative basis, too. Given that around 75% of them are manufactured products, all is not lost.
Where then will growth come from? A major source of strength for the economy is the farm sector, which is posed to register a second successive high growth rate this year. It is quite impressive, given that new peaks were set in FY11. The rabi news also appears to be good in terms of sowing, which, in turn, should provide the requisite support. This higher growth will also get reflected in higher spending in rural India for manufactured goods, which, in turn, should provide the backward linkages to industry. This is good news.
But with agriculture actually accounting for around 14% of GDP, it can support and not really propel the economy. This is where the service sector comes into the frame. With a share of nearly 65% in the economy, it has been the driving force, with growth of around 9% so far, which will be expected to continue in the second half. The corporate sector is still maintaining top line growth while profits have been affected quite drastically this year. But service sector support can be a one-time affair, and cannot be sustained over a longer time frame as this sector cannot grow unless there is real production taking place.
Amid these relatively low-growth scenarios, the financial environment appears to be a bigger constraint starting with inflation. Both WPI and food inflation remain high (Graph 4) and while it will come down towards the targeted 7% level by March due to the good harvests, high base effect and declining global commodity prices (to the extent that it is not diluted by rupee depreciation), monetary policy stance will remain neutral for the rest of the year. Therefore, the investment climate will not change too soon as interest rates will continue to be under pressure until such time that RBI considers a reversal of its stance.
The other factor coming in the way of growth has been the uncertainty on the fiscal side. A slippage is expected, given that the government gave away around R50,000 crore as duty cuts on oil products and also increased the size of its borrowing programme by a similar amount. Now, the crux is whether it will go the Keynesian way and continue with spending—as it is the only entity that can do so at interest rates which come in the range of 8.5-9% (the corporate sector pays base rate of 10-11% plus spread). With pressure to rein in the deficit and the spectre of disinvestment not taking off, revenue declining due to low corporate and industrial growth, and subsidy bill bursting, the focus appears more on controlling rather than fulfilling expenditure programmes.
On this entire canvas of scepticism we have also seen some positive signs from the outside world. FDI has been coming in larger numbers despite the current climate. Clearly, there is faith in the growth story as such investment takes a medium- to long-term view (Graph 5). ECB approvals have increased during the first six months indicating substitution of cheap funds for dearer means of finance.
Where does this really take us? Our story is more like modern impressionistic art. Yes, the pictures are disjointed and hard to interpret cogently, which is a case with all such art. The number of 7% is still actually not bad when the world economies are crawling in sub-2% numbers. The government is struggling with the deficit and policy reforms, while RBI is grappling with all the jigsaw pieces of the financial markets. Maybe it is the clichéd jugaad, but the Indian economy still will manage the bumpy road.
Growth prospects appear to have descended the stairs and the initial enthusiasm on the decoupling theory with the euro crisis has now given rise to second thoughts and apprehension. Inflation is a worry, not so much because it is high but because we have not really cracked a way out. Now the fiscal deficit and weak rupee have generated a fresh set of challenges for RBI and the tension is palpable. But somewhere within the periphery we have seen higher foreign direct investment and larger recourse to external commercial borrowings (ECBs) provide colour to the portrait. How then does the growth story really add up?
Our own growth expectations have scaled down considerably from the 9% assumed in the Budget to something around 7-7.5%, going by the latest
remarks by the finance ministry (Graph 1). Given that RBI has kept increasing interest rates in a bid to curb demand, this lower growth is a vindication of monetary policy as investment, leverage-based consumption and overall growth has slowed down.
Industrial growth has been declining in the last few months (Graph 2) and while there is still reason to remain sanguine, considering that this has been the slack season where there is relatively less spending, we may still not really expect a major jump in the subsequent months even with higher consumption spending. The major disappointment has been the mining sector that has gone into the negative zone, but electricity production has been robust, thus sending contrary signals.
Further, bank credit growth has slowed down, indicating that there is definitely less borrowing for production and investment. However, at the same time, there has been a steady increase in both exports and non-oil imports (Graph 3), though, admittedly, there is a declining trend. Imports go either as direct consumption or inputs for production; either which way it should get reflected in overall growth. The same holds for exports, which have been buoyant on a cumulative basis, too. Given that around 75% of them are manufactured products, all is not lost.
Where then will growth come from? A major source of strength for the economy is the farm sector, which is posed to register a second successive high growth rate this year. It is quite impressive, given that new peaks were set in FY11. The rabi news also appears to be good in terms of sowing, which, in turn, should provide the requisite support. This higher growth will also get reflected in higher spending in rural India for manufactured goods, which, in turn, should provide the backward linkages to industry. This is good news.
But with agriculture actually accounting for around 14% of GDP, it can support and not really propel the economy. This is where the service sector comes into the frame. With a share of nearly 65% in the economy, it has been the driving force, with growth of around 9% so far, which will be expected to continue in the second half. The corporate sector is still maintaining top line growth while profits have been affected quite drastically this year. But service sector support can be a one-time affair, and cannot be sustained over a longer time frame as this sector cannot grow unless there is real production taking place.
Amid these relatively low-growth scenarios, the financial environment appears to be a bigger constraint starting with inflation. Both WPI and food inflation remain high (Graph 4) and while it will come down towards the targeted 7% level by March due to the good harvests, high base effect and declining global commodity prices (to the extent that it is not diluted by rupee depreciation), monetary policy stance will remain neutral for the rest of the year. Therefore, the investment climate will not change too soon as interest rates will continue to be under pressure until such time that RBI considers a reversal of its stance.
The other factor coming in the way of growth has been the uncertainty on the fiscal side. A slippage is expected, given that the government gave away around R50,000 crore as duty cuts on oil products and also increased the size of its borrowing programme by a similar amount. Now, the crux is whether it will go the Keynesian way and continue with spending—as it is the only entity that can do so at interest rates which come in the range of 8.5-9% (the corporate sector pays base rate of 10-11% plus spread). With pressure to rein in the deficit and the spectre of disinvestment not taking off, revenue declining due to low corporate and industrial growth, and subsidy bill bursting, the focus appears more on controlling rather than fulfilling expenditure programmes.
On this entire canvas of scepticism we have also seen some positive signs from the outside world. FDI has been coming in larger numbers despite the current climate. Clearly, there is faith in the growth story as such investment takes a medium- to long-term view (Graph 5). ECB approvals have increased during the first six months indicating substitution of cheap funds for dearer means of finance.
Where does this really take us? Our story is more like modern impressionistic art. Yes, the pictures are disjointed and hard to interpret cogently, which is a case with all such art. The number of 7% is still actually not bad when the world economies are crawling in sub-2% numbers. The government is struggling with the deficit and policy reforms, while RBI is grappling with all the jigsaw pieces of the financial markets. Maybe it is the clichéd jugaad, but the Indian economy still will manage the bumpy road.
Inflated incomes, growth and inflation: Financial Express: 9th December 2011
There is a new dimension to the inflation conundrum. A thought that comes to mind is whether higher prices have also been driven by higher incomes. This is so because, so far, we are talking of cost-push or demand-pull inflation as the causes; and debates, if not policies, have been geared towards this direction. But if incomes or the classic wage-push forces have played their role, then we need to think differently as our growth model has to be reviewed as it affects future scenarios.
Let us look at different segments of the workforce. The organised sector is affected by various factors such as annual pay increases, adjustment to dearness allowance, bonuses, revisions based on pay commissions for public sector employees, Esops and so on. All these increase the spending power, which, in turn, puts pressure on the demand side, and which goes beyond the purview of RBI as there is no leverage involved. Further, the capital market gives steady returns, which are used for spending and reinvestment.
In the organised segment, public sector banks may be taken to be a proxy for the public sector (excluding government). The average salary per employee increased from R3.71 lakh in FY06 to R7.15 lakh in FY11, a rise of 93%. Interestingly, the average pay rose by 53% in the last two years. If we turn to the central government employees in the last two years, the average pay has risen by 29% from R2.61 lakh to R3.37 lakh based on information in the budget and the census of central government employees. A large part of this is driven by the usual increases in salary that are not dependent on business conditions, as well as adjustments for inflation in the form of dearness allowances. Add to this the pay hikes due to the pay commission along with arrears being spaced over a period of time and we do have a fair degree of affluence being added to these incomes.
If one looks at, say, foreign banks, which broadly represent what happens in the higher income organisations, the increase has been around 20% in the last two years, with the average pay increasing from R16.11 lakh to R19.31 lakh. In FY06, the average was just about R7 lakh. Here, the increase in the five-year period has been around 1.7 times. The moderation witnessed in the last two years may be attributable more to the financial crisis of 2007-09 when these organisations became conservative with their pay packages.
Has the same happened in the rural areas? Here it is a tough call on account of absence of information. But, two proxies may be used. The first is the wages paid in the MGNREGA programme, which have risen from an average daily wage of R90 in FY09 to R118 in FY11, an increase of 31%. Although this scheme is not fully utilised by the labour, it nevertheless sets benchmarks for minimum wages to be paid. This upward thrust can be seen in the wages demanded by the labour in rural India.
Second, the food inflation numbers, by themselves, tell us about incomes being earned. Now, in the last five years, prices of primary articles increased by around 75%, of which 47% was witnessed in the last three years. Either way, it means that rural incomes from farming have been increasing by an average of 15% per annum in the last five years, which means enhanced spending power. This has been aided by higher MSPs announced by the government, which sets new benchmarks.
Evidently, there has been a lot of income increases across all segments, which have provided the required fillip. As GDP growth was buoyant, it meant that goods were being produced for consumption. But this has come with a heavy cost of inflation, which is a concern because the traditional tools for price control cease to work if we have wage-inflation. A good example is price of food. When prices rise, and demand comes down, then prices would have to be lowered. However, today this is not the case and consumers are still spending their incomes on costlier vegetables and foodgrains as they have the wherewithal to do so. The fact that salaries have increased down the line—domestics, laundry, chauffeurs, security personnel, etc, are also earning more—means that purchasing power has not really been controlled and we are living with new price levels. It is probably the fixed income earners who are impacted as they get limited recourse from RBI through interest rate hikes.
The major implication here is for growth and the model has to be revisited. Growth has been driven by high incomes and high inflation, albeit unconsciously and is not sustainable in the long run as we run the risk of galloping inflation, if not checked. Somewhere we have to break this chain or else this double-digit rate, which we term by the cliché stubborn, will only keep growing and conventional policy responses will be impotent. This is certainly not a good sign.
Let us look at different segments of the workforce. The organised sector is affected by various factors such as annual pay increases, adjustment to dearness allowance, bonuses, revisions based on pay commissions for public sector employees, Esops and so on. All these increase the spending power, which, in turn, puts pressure on the demand side, and which goes beyond the purview of RBI as there is no leverage involved. Further, the capital market gives steady returns, which are used for spending and reinvestment.
In the organised segment, public sector banks may be taken to be a proxy for the public sector (excluding government). The average salary per employee increased from R3.71 lakh in FY06 to R7.15 lakh in FY11, a rise of 93%. Interestingly, the average pay rose by 53% in the last two years. If we turn to the central government employees in the last two years, the average pay has risen by 29% from R2.61 lakh to R3.37 lakh based on information in the budget and the census of central government employees. A large part of this is driven by the usual increases in salary that are not dependent on business conditions, as well as adjustments for inflation in the form of dearness allowances. Add to this the pay hikes due to the pay commission along with arrears being spaced over a period of time and we do have a fair degree of affluence being added to these incomes.
If one looks at, say, foreign banks, which broadly represent what happens in the higher income organisations, the increase has been around 20% in the last two years, with the average pay increasing from R16.11 lakh to R19.31 lakh. In FY06, the average was just about R7 lakh. Here, the increase in the five-year period has been around 1.7 times. The moderation witnessed in the last two years may be attributable more to the financial crisis of 2007-09 when these organisations became conservative with their pay packages.
Has the same happened in the rural areas? Here it is a tough call on account of absence of information. But, two proxies may be used. The first is the wages paid in the MGNREGA programme, which have risen from an average daily wage of R90 in FY09 to R118 in FY11, an increase of 31%. Although this scheme is not fully utilised by the labour, it nevertheless sets benchmarks for minimum wages to be paid. This upward thrust can be seen in the wages demanded by the labour in rural India.
Second, the food inflation numbers, by themselves, tell us about incomes being earned. Now, in the last five years, prices of primary articles increased by around 75%, of which 47% was witnessed in the last three years. Either way, it means that rural incomes from farming have been increasing by an average of 15% per annum in the last five years, which means enhanced spending power. This has been aided by higher MSPs announced by the government, which sets new benchmarks.
Evidently, there has been a lot of income increases across all segments, which have provided the required fillip. As GDP growth was buoyant, it meant that goods were being produced for consumption. But this has come with a heavy cost of inflation, which is a concern because the traditional tools for price control cease to work if we have wage-inflation. A good example is price of food. When prices rise, and demand comes down, then prices would have to be lowered. However, today this is not the case and consumers are still spending their incomes on costlier vegetables and foodgrains as they have the wherewithal to do so. The fact that salaries have increased down the line—domestics, laundry, chauffeurs, security personnel, etc, are also earning more—means that purchasing power has not really been controlled and we are living with new price levels. It is probably the fixed income earners who are impacted as they get limited recourse from RBI through interest rate hikes.
The major implication here is for growth and the model has to be revisited. Growth has been driven by high incomes and high inflation, albeit unconsciously and is not sustainable in the long run as we run the risk of galloping inflation, if not checked. Somewhere we have to break this chain or else this double-digit rate, which we term by the cliché stubborn, will only keep growing and conventional policy responses will be impotent. This is certainly not a good sign.
Yehi hai right choice! Financial Express 28th November 2011
If organised retail is acceptable and adds value to the food chain by delivering superior results through better logistics, shopping experiences and prices, then getting in FDI is really no different. Logically, the fact that investment is by a foreigner and not an Indian should not be a limitation. Against this premise, the government’s decision to permit up to 51% in multi-brand retail is more than welcome.
There are basically three sets of issues that should be understood: the advantages of FDI, the concerns on this score and lastly the issues for foreign investors in this space.
FDI is actually a win-win situation for us in India where there is limited infrastructure for fully harnessing our farm production. By putting in conditions of back-end investment, we are actually ensuring that the requisite infrastructure in the form of warehousing including cold storage, transport, processing, packing and packaging develop along with this model. Also, by putting a 30% norm on procurement from small units, the issue of inclusion is addressed. The build-up of strong logistics support can actually change the shape of our farm sector by cutting down on wastages, improving efficiency and lowering costs. At the end of the day, prices have to come down or else there will not be takers.
The interesting aspect of FDI in this space is the procurement process. While it will be through the regular channels, a difference will be made in terms of quality and pricing. Quality enhancements are a corollary of such models as there will be insistence on specifications. Curiously, this has worked well in India ever since futures trading were restored. Farmers now have migrated to growing exchange specified qualities, which, in turn, has set benchmarks. Hence, the NCDEX sugar or NCDEX chana or NCDEX soybean has become a norm, which provides better prices to the farmer.
The other issue is on pricing. The entry of large corporates in India, like ITC’s e-chaupal, has actually led to better prices being provided to farmers with added transparency. FDI here will only accelerate this process. An interesting thought here is whether we will actually see the proliferation of contract farming, which will greatly assist our agricultural sector as it will go according to the investors’ specifications.
Therefore, from the point of view of the system as well as consumers, FDI should be welcome as this will also bring along higher employment along the entire value chain and create the necessary skill sets. Will this be what in economics is called a Pareto Optimal situation, where some are better off and no one worse off?
There are some concerns here on what happens to the mom-and-pop (M-P) stores with the Walmarts and Tescos making strong inroads. The experience of organised retail in India shows that nothing has actually changed though, admittedly, their scale of operations is limited. The M-P stores actually have certain distinct advantages over organised retail stores. They can be located anywhere and closer to the consumer. They provide credit facilities and home delivery services. Further, they are flexible with their packaging and deal with all brands—the lesser known indigenous ones to the bigger ones, hence catering to all price segments. The same cannot be replicated by organised retail. Also, the fact that you can phone in and get your stuff makes a difference. Further, Indians, as a rule, like to physically feel the products, which is not possible in case of packaged goods. Therefore, the fear of displacement is not really founded. One must remember that, given the space required for organised retail, they cannot be there everywhere and the M-P stores have an advantage.
The challenge is more for the investors. Given the limited success of organised retail and the 5-10 years break-even, there will be serious thinking on their part. The fact that our market is large with growing population and incomes is a teaser. Further, given that less than 5% is organised means that there is space for more operators. Their experience in other developing markets will help in replicating these models with modifications. But, two issues stand out. The first is the cost of operations, given that property is expensive as are rents and other operating costs. Second, a practical problem relates to resistance from local population. It has already been seen that organised retail has been driven out in certain states. Hence, while the entry into metro cities may be easier, as they proliferate to tier-2 and tier-3 cities and rural areas, there would be a lot of resistance. This is beyond Parliament and legislation.
What then can we expect? We can expect FDI of around $5-10bn to come in the first few years. Such investment will strengthen in a limited way the infrastructure needed in the farm sector. It will be confined to the metro and larger cities to begin with, which will not really cause distortions to the M-P stores. The impact on improved supplies and inflation will be felt only when organised domestic and FDI retail is able to actually reach out to around 30-40% of total retail sales. Or else there will only be pockets of improvement in specific geographies and sectors. The policy is definitely progressive and, more importantly, brings in the dollars for us.
There are basically three sets of issues that should be understood: the advantages of FDI, the concerns on this score and lastly the issues for foreign investors in this space.
FDI is actually a win-win situation for us in India where there is limited infrastructure for fully harnessing our farm production. By putting in conditions of back-end investment, we are actually ensuring that the requisite infrastructure in the form of warehousing including cold storage, transport, processing, packing and packaging develop along with this model. Also, by putting a 30% norm on procurement from small units, the issue of inclusion is addressed. The build-up of strong logistics support can actually change the shape of our farm sector by cutting down on wastages, improving efficiency and lowering costs. At the end of the day, prices have to come down or else there will not be takers.
The interesting aspect of FDI in this space is the procurement process. While it will be through the regular channels, a difference will be made in terms of quality and pricing. Quality enhancements are a corollary of such models as there will be insistence on specifications. Curiously, this has worked well in India ever since futures trading were restored. Farmers now have migrated to growing exchange specified qualities, which, in turn, has set benchmarks. Hence, the NCDEX sugar or NCDEX chana or NCDEX soybean has become a norm, which provides better prices to the farmer.
The other issue is on pricing. The entry of large corporates in India, like ITC’s e-chaupal, has actually led to better prices being provided to farmers with added transparency. FDI here will only accelerate this process. An interesting thought here is whether we will actually see the proliferation of contract farming, which will greatly assist our agricultural sector as it will go according to the investors’ specifications.
Therefore, from the point of view of the system as well as consumers, FDI should be welcome as this will also bring along higher employment along the entire value chain and create the necessary skill sets. Will this be what in economics is called a Pareto Optimal situation, where some are better off and no one worse off?
There are some concerns here on what happens to the mom-and-pop (M-P) stores with the Walmarts and Tescos making strong inroads. The experience of organised retail in India shows that nothing has actually changed though, admittedly, their scale of operations is limited. The M-P stores actually have certain distinct advantages over organised retail stores. They can be located anywhere and closer to the consumer. They provide credit facilities and home delivery services. Further, they are flexible with their packaging and deal with all brands—the lesser known indigenous ones to the bigger ones, hence catering to all price segments. The same cannot be replicated by organised retail. Also, the fact that you can phone in and get your stuff makes a difference. Further, Indians, as a rule, like to physically feel the products, which is not possible in case of packaged goods. Therefore, the fear of displacement is not really founded. One must remember that, given the space required for organised retail, they cannot be there everywhere and the M-P stores have an advantage.
The challenge is more for the investors. Given the limited success of organised retail and the 5-10 years break-even, there will be serious thinking on their part. The fact that our market is large with growing population and incomes is a teaser. Further, given that less than 5% is organised means that there is space for more operators. Their experience in other developing markets will help in replicating these models with modifications. But, two issues stand out. The first is the cost of operations, given that property is expensive as are rents and other operating costs. Second, a practical problem relates to resistance from local population. It has already been seen that organised retail has been driven out in certain states. Hence, while the entry into metro cities may be easier, as they proliferate to tier-2 and tier-3 cities and rural areas, there would be a lot of resistance. This is beyond Parliament and legislation.
What then can we expect? We can expect FDI of around $5-10bn to come in the first few years. Such investment will strengthen in a limited way the infrastructure needed in the farm sector. It will be confined to the metro and larger cities to begin with, which will not really cause distortions to the M-P stores. The impact on improved supplies and inflation will be felt only when organised domestic and FDI retail is able to actually reach out to around 30-40% of total retail sales. Or else there will only be pockets of improvement in specific geographies and sectors. The policy is definitely progressive and, more importantly, brings in the dollars for us.
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